Friday, September 23, 2011

Ben Bernanke and “The Costanza Effect”

 “This is found money.  I want to parlay it.  I wanna make a big score!”
—George Costanza, of Seinfeld, on interest income

 We were having a back-and-forth via Twitter this morning with a friend of this blog, a very smart reporter who had taken issue with our non-economist-trained view that Ben Bernanke was not
saving the U.S. economy by suppressing interest rates at near-zero levels: he was, rather, pushing the U.S. into a depression by killing the interest-rate spread on which the very banks that circulate the life-blood of the system live.
 Interest rates, we argued, were not, as Bernanke has believed, too high for the good of the country, they were too low.
 Logically, our friend responded that if credit were really as underpriced as we claimed, “Savers would surely use underpriced credit to snap up inflating assets and goods. They’re not.”
 And he is right.
 However, the reason savers are not jumping out of no-longer-interest-earnings savings accounts and into risky asset pools is not that rates have been too high.  We think it is a function of the fact that, at a certain point, low interest rates become counter-productive: they make savers more cautious, not less.  Interest rates are, we think, too low.
 After all, if you’re not earning anything on the money you have in the bank, your instinct is not to take it down to the track and go bet the whole bundle on Greased Lightening, as Tony Curtis’ character did in “Some Like It Hot.”
 No, you’re going to sit tight.
 Now, this behavior probably has some fancy economist-type label, but we will hereby declare it to be a reverse-manifestation of “The Costanza Effect,” after George Costanza of Seinfeld fame.
 In one episode, George, upon receiving notice of an old passbook savings account with accumulated interest, chooses not to keep the money in the bank, but to gamble it away.
 George: “The State Controller’s Office tracks me down.  The interest has accumulated to 1,900 dollars.  1,900 dollars!  They’re sending me a check!”…
Jerry:  “Why don’t you put it in the bank?”
George: “The bank?  This is found money.  I want to parlay it.  I wanna make a big score.”
Jerry:  “Oh, you mean you wanna lose it…”
 We think “The Costanza Effect” illustrates that people are more willing to risk found money than earned money, and thereby explains precisely the Bernanke dilemma, whereby interest rates have dropped to zero and yet savers have reacted with exactly opposite the intended result.
 Far from, as our friend wrote, “use underpriced credit to snap up inflating assets and goods”; they have chosen to sit on what they have.
 Kramer for Fed Chairman, anyone?

Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at

© 2011 NotMakingThisUp, LLC
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Mark said...

I was going to call this theory "intriguing," but honestly, it sounds more like one of the silly academic (i.e., non-real world) theories generated by Bernanke and his no-common-sense pals at the Princeton economics department.

The reason near-zero interest rates aren't helping any isn't exactly rocket science (and I know that because just as Jeff is no economist, I'm no rocket scientist): it's simply that there's still way too much household debt out there, and until more of it is paid off or defaulted on there won't be enough buying power to create the demand necessary to warrant additional capital investment.

Unable to simply acknowledge this fact (and thus face the unpleasant possibility that "time" is the only real cure for what ails us) politicians, economists and, yes, blogging hedge fund managers are instead coming up with all kinds of "pro-active" policies that solve nothing.

Yes, a flatter & broader tax structure and more common-sense regulation would definitely be helpful on the margins, but really just on the margins (although those changes should absolutely be made). But all this other crazy Fed tinkering reminds me of an old line (and I'm paraphrasing here) from the late, great George Peppard, who was a lifelong alcoholic:

"You have a problem so to make yourself feel better you start drinking. Now you have two problems."

Anonymous said...

I am wondering if, in response to 0% interest and ongoing inflation, savers would not just go out and stock up on consumer goods that are rising in price; e.g., canned or packaged foods that are unperishable. Buy all the things now you know you'll need in future. Is there a canned goods ETF yet?

Namazu said...

There are probably a half dozen plausible explanations, all valid to one degree or another. I propose an obvious one: lower income on savings requires a lower concentration of risk assets to achieve the same expected returns with the same level of risk. Less obviously, or at least more open to debate, the Fed is dampening animal spirits by signaling a negative outlook on the economy. Of course, George is right at the meta-level of how risk tolerance relates to social mood.

Anonymous said...

@ Jeff,

Unfortunately, this is one of your dumber posts.

Try to get a loan these days -- if you're a consumer or small business? Nearly impossible. We have a lending crisis from banks who are too shell shocked from the bad loans still on the books, the uncertainty and risks in the global economy, etc., etc.

Gee wonder why everyone from consumers to F500 are sitting on cash. Sarcasm intended.

Daniel M said...

Your thoughts may find some support in Daniel Kahane's "Prospect Theory".

Colin P, Del Boca Vista, FL said...

Lloyd Braun or Jerry's cousin, Jeffrey, who works in the Parks Department would be better as Chairman than Kramer.

Jeff Matthews said...

If Mark's notion that the reason near-zero rates isn't helping is that there's too much household debt out there is correct...then why wouldn't zero rates help those in debt?

Seems to us Bernanke has created "two problems" by lowering rates to zero while banks have stopped lending anyway.

As for the Anonymous who believes the issue relates to the impossibility of getting loans, we agree 100% that it is near-impossible to get loans--even to refinance a house with positive equity is very difficult now that the banks are insisting on documentation and minimum equity levels (10 years too late).

However that doesn't explain why the debt-free consumer has frozen his or her cash in bank deposits rather than shift those risk-free assets into risky assets, which is what Bernanke is trying to accomplish, mistakenly, with zero rates.

We believe the Costanza Effect explains the issue exactly.

And thank you Colin from Del Boca Vista. We love the idea of Lloyd Braun, or Jeffrey from the Parks Department, settling into Bernanke's seat at the Fed.

Or what about Crazy Joe Davola?


Mark said...

>>If Mark's notion that the reason near-zero rates isn't helping is that there's too much household debt out there is correct...then why wouldn't zero rates help those in debt?<<

Sure they help a bit... But not with 14% credit card bills or a mortgage that's just too damn big (at ANY interest rate) relative to one's income.

Colin P, Del Boca Vista, FL said...

Lloyd Braun and Jeffrey from the Parks Department have experience working in government. I think it goes without saying, they must know what they're doing.

Crazy Joe Davola? I could support that, provided, Bob Sachimano is named Chairman of the NY Fed.

Also, the Joe Davola episode was on TBS yesterday.

Anonymous said...

Totally true Jeff. As a personal example, I have an above average financial education but I'm doing the reverse Costanza.
My only debt is a variable-rate mortgage and it's got 20 years left. I don't think about it.

If the economy was booming and banks were the only low payer, maybe I'd shift my cash into bonds or more stocks. Banks pay close to zero yet it's better than putting it into a stock right now and watching it drop another 10%. Savers aren't in it to take risk or to make "rational decisions" on statistics to "maximise expected future value" or overcome a money illusion bias. We're savers because we don't want to lose. The number in my account must not go down.

Anonymous said...


A couple quick questions:

Does it matter that the money George wants to bet is truly found money? He wasn't watching his savings accrue at the bank he got himself an unexpected check in the mail. If we want a Constanza Bounce we need to mail checks. Still in favor?

Supposing that the underlying theory is correct if misnamed (per the above) how high should interest rates be so that folks accrue enough interest to get them interested in betting the interest? If we apply no break to the logic of your theory we must conclude that if we really want to get the animal spirits animated we should jack rates up 10-20-30-50%...etc.

Anonymous said...

C'mon Jeff, THE DRAKE would be a great Fed Chairman.

Everyone loves THE DRAKE.

Anonymous said...

"There are probably a half dozen plausible explanations, all valid to one degree or another. I propose an obvious one: lower income on savings requires a lower concentration of risk assets to achieve the same expected returns with the same level of risk"

I think Namazu got it exactly. I am soone going into retirement, and the few thousand (remember when a tresary payed 6% - ahh, the good old days)I earned in interest was "found money" that I spent. I am going into a situation where my financial options are much more limited. Reducing my income of course means less spending. No interest, no spendy.

Citizen AllenM said...

anonymous said: We're savers because we don't want to lose. The number in my account must not go down.

Then you do lose, because we will have inflation again, whether you like it or not.

That kind of risk aversion is a trap, one of the best intentions, but a trap.

Jeff, you are missing the point, the loss of interest rate is to help the banks out period, by cutting their costs of funds to near zero, and anonymous is helping them out by parking his cash.

The real problem is banks are not doing the analysis that offering interest rate reductions to big and small debtors would be an effective way to recover more funds than pushing them into default faster.

The entire market for houses illustrates the point clearly. Look at the banks which run the servicers- they push foreclosures because they make money up front, and the debt holders (uh, not the banks btw- remember all of those loans that were wrapped up and sold?) take it in the shorts, and the banks run the trusts that are being destroyed, but won't write down principle and lower interest rates on those trust's paper.

Perfect spiral.

Now, common sense would dictate that getting 19% interest on a debt that defaults in a year is worth much less than 5% interest on a debt that doesn't default, but if the bank needs the cashflow, and the bottom has been securitized, the incentives give you today's markets.

And you don't think markets can fail, eh?

So now you think that zero interest rates are having the constanza effect because they discourage investment? The real question is what is worth investing in when you have a deflationary spiral with no wage growth, no asset growth, and no growth, but indeed contraction?

Look to the underlying health of the working folks, and the use of debt to substitute for income, and the loss of increasing income (which under miller modigliani makes sense if you have inflation and increasing incomes), and you enter a zero bound debt trap.

Simple if you get out of running a household and think in terms of a macroeconomy based microfoundations.

Anonymous said...

I agree with Anonymous. The interest rate is meaningless if the banks won't lend. They blame it on the regulators that have swung the pendulum so far that not only are the credit departments spending all their time with the various regulators, but there isn't a credit on earth that isn't getting the evil eye.

While the bank's spreads are thin,it is sufficient to cover expenses with no risk or headaches.

Jeff Matthews said...

Agree that the interest rate is meaningless to the borrower if the banks won't lend.

However, rates are meaningful to savers.

Therefore, all the rate cuts do is decimate savers, not help borrowers.


Anonymous said...

You are exactly right. People are sitting on the sidelines and waiting.I'm one of them. The reason has less to do with the interest rate and more to do with a lack of confidence that the assest you would be buying with the "cheep" borrowed money or your cash will either not hold its value or will underperform any projected return expectations and you ,the buyer, will be stuck holding the bag. Confidence+cheep money=inflation...
uncertainty+cheep money=stagflation , disinflation and or deflation

Anonymous said...

Hi AllenM,
My adviser says he needs a drink. It's 10am. And I should give him more? No way. Cash may eventually be a trap, but it isn't yet. And cash is liquid, I can move it out in the future. For now it stays in the bank because there's no other safe spot, no broad categories of safe investments, and stagflation hasn't kicked in. When it does, I'll think again.
To Anon#1, I live in a tiny place of a few hundred square feet. No space to buy and store stuff, even though I'd love to buy in bulk. Such is the urban life.

Jason said...

I'm with Anon at 4:36 PM on 9/26. I'm taking the inflation risk/negative carry b/c I am worried that any asset I buy is inflated by the low rates/government effort to keep asset prices high. We are stuck. I'd feel much better about investing if the government were to stop interfering in the market. To road from here to less government support looks ugly to me, so I park money.

Anonymous said...

“Savers would surely use underpriced credit to snap up inflating assets and goods. They’re not.”

In 2009 I borrowed $15,000 at 2% to buy 1,000 ounce of siver bullion. Probably not the wisest policy in the world, but I have no regrets.


ShaunP said...

There is some solid merit to this theory. Michael Pettis referenced a study some time back about how high interest rates in China actually fuelled inflation because the savings rate decreased in anticipation of a higher rate of return on deposits. But, I do not think this is the case in least not totally. Tight money is more of a feature of an ageing economy like ours. (Japan is a good example of an extreme outcome of this.) Anyways, this example only gives further credence to NGDP targeting proposed by Scott Sumner. Focusing on growth and less on inflation raises inflation and growth and therefore raises interest rates.

Anonymous said...

If you look at the real world for a minute, you will see that banks are making bigger than ever spreads (profits) on mortgage issuance.
What they charge customers (rate) is so far above what they get in the secondary market (packaged mortgage backed securities) that they are making $ hand over fist. There is some debate about WHY they are making such a great spread, but the fact is, they're doing better than ever with low rates. Why speculate when you can look stuff up?